> National Income is defined as the net value of + all economic goods and services produced + within the domestic territory of a country + in.an Accounting Year + plus the Net Factor Income from Abroad (NFYA) Explain the usefulness and significance of National Income estimates, ‘Answer National income accounts are extremely useful, for following: @ Evaluating the Short Run Performance: ‘+ Provide @ comprehensive, conceptual and accounting framework for analyzing and evaluating the short-run performance of an economy. + The level of national income indicates the level of economic activity and economic development. (i) Determines Present and Future Demand: + The distribution pattern of National Income determines the pattern of demand for goods and services, and + Enables businesses to forecast the future demand for their products. (ii) Measure of Economic Welfare ‘Economic welfare demand on the magnitude and distribution of national income, size of per capita income and the growth of these over time (i) International Comparisons: ‘+ International comparisons in respect of incomes and living standards assist in determining eligibility for loans, and/or other funds or conditions on which such loans, and/or funds are made available. (2) Economic Forecasting: + National income or a relevant component of it is an indispensable variable considered in ‘economic forecasting and to make projections about the future development trends of the ‘economy. Contact No, 9211122778 Page LL.1What is UN System of National Accounts (SNA)? ‘Answer: UN System of National Accounts (SNA) developed by United Nations to provide a comprehensive conceptual and accounting framework for compiling and reporting macroeconomic statistics for enclyzing and evaluating ‘the performance of an economy. Explain three sides of NIA. National income accounts have three sides: a product side, an expenditure side and an income side: O Product Side: @ & Side: Gi) Income Side: National income is the sum total of all the incomes accruing over a specified period to the residents of a country ond consists of wages, salaries, profits, rent and interest Explain the Gross Domestic Product (GDP) + Gross domestic product (GOP) is a measure of the market value of all final economic goods and services, gross of depreciation, produced within the domestic territory of a country during a given time period. ‘+ Tt is the sum total of ‘value added’ by all producing units in the domestic territory and includes value added by current production by foreign residents or foreign-owned firms. ‘+The term ‘gross’ implies that GDP is measured ‘gross’ of depreciation. ‘+ ‘Domestic’ means domestic territory or resident production units. + GDP excludes transfer payments, financial transactions and non- reported output generated ‘through illegal transactions such as narcetics and gambling (these are also known as ‘bads' as ‘opposed to goods which GDP accounts for). Contact No, 9211122778 Page 1.1.2w Gi) 7) wo Only Final Goods and Services: Intermediate Consumption: ‘© Intermediate goods used to produce other goods rather than being sold to final purchasers are rot counted as it would involve double counting, easnaiae Actin ‘+ Economic Activities and Non-Economic Activities include all human activities which create goods ‘and services that are exchanged in a market and valued at market price. ‘Flow Concept: ‘= National income is a “flow’ measure of output per time period—for example, per year—and includes only those goods and services produced in the current peried, Inventory Investment: ‘= The net change in inventories of final goods awaiting sale or of materials used in the production which may be positive or negative. Additions te inventory stocks of final goods and materials belong to GDP because they are currently produced output. Explain Nominal GDP v/s Real GDP, i.e. GDP at current and constant prices. Explain Gross National Product (GNP). Gross National Product (GNP) is a measure of the market value of all final economic goods and services, gross of depreciation, produced within the domestic territory of @ country by normal residents during an accounting year including net factor incomes from abroad. Gross National Product (GNP) is evaluated at market prices Contact No, 9211122778 Page 1.13Chapter-1, Unit-I: National Income Accounting By: CA Nitin Guru © Note: NFIA is the difference between the aggregate amount that a country's citizens and companies earn ‘abroad, and the aggregate amount that foreign citizens and overseas companies earn in that country. ‘+ Tf Net Factor Income from Abroad is positive, then GNPy would be greater than GDPy. Explain Net Domestic Product at market prices (NDP). Net domestic product ot market prices (NOP MP) is a measure of the market value of all final economic goods and services, produced within the domestic territory of a country by its normal residents and non residents during an accounting year less depreciation. Explain Net Notional Product at Market Prices (NNPw). ‘Answer: Net National Product at Market Prices (NNP MP) is a measure of the market valie of all final economic goods and services, produced by normal residents within the domestic territory of a country including Net Factor Tneome from Abroad during an accounting year excluding depreciation. Contact No, 9211122778 Page 1.14Chapter-1, Unit-I: National Income Accounting By: CA Nitin Guru Explain Gross Domestic Product at Factor Cost (6DPr.). Explain Net Indirect Tax MF inibecrlvess > abl Explain Net Domestic Product at Factor Cost (NDPrc). Explain Net National Product at Factor Cost (NNPr<) or National Income. Contact No, 9211122778 Page 1.15‘+ The GDP per capita is a measure of a country's economic output per person. ‘+ Tt is obtained by dividing the country’s gross domestic product, adjusted by inflation, by the total population. Tt serves as an indicator of the standard of living of a country. Explain Measurement of National Income in India. ‘Answer ‘+ Notional Accounts Statistics (NAS) in India are compiled by National Accounts Division in the Central Statistics Office, Ministry of Statistics and Programme Implementation, ‘+ Amal as well as quarterly estimates are published, ‘+ As per the mandate of the Fiscal Responsibility and Budget Management Act 2003, the Ministry of Finance uses the GDP rumbers (at current prices) to determine the fiscal targets. ‘+ Now, the base year has revised from 2004-05 to 2011-12. Explain the Value Added Method, Income Method , Expenditure Method. Explain the system of regional accounts in India, The system is as explained below: + Regional accounts provide an integrated database on the innumerable transactions taking place in the regional economy and help decision making at the regional level. ‘+ All the states and union territories of India compute state income estimates and district level estimates. State income or Net State Domestic Product (NSDP) is a measure n monetary terms of ‘the volume of all goods and services preduced in the state within a given period of time. + Per Capital State Income is obtained by dividing the NSDP (State Income) by the midyear projected population of the state + The state level estimates are prepared by the State Income Units of the respective State Directorates of Economics and Statistics (DES) What are Supra-regional sectors? Contact No, 9211122778 Page 1.1.6Chapter-1, Unit-I: National Income Accounting By: CA Nitin Guru ‘The Supra-regional sectors are explained as below: Certain activities such as railways, communications, banking and insurance and central government odministration, that cut across state boundaries, and thus their economic contribution cannot be assigned to any one state directly and are known as the 'Supra-regional sectors' of the economy. The estimates for these supra regional activities are compiled for the economy as a whole and allocated to the states on the basis ef relevant indicators, Explain the limitations and challenges of National Income computation. Answer The limitations are explained as below: GDP measures ignores the following ~ °) » ° 2 f 9 » Inadequate measure of welfare - Countries may have significantly different income distributions and, consequently, different levels of overall well-being for the same level of per copital income. Ignores Qualitative data - Quality improvements in systems and processes due to technological as well ‘as managerial innovations which reflect true growth in output from year to year. Doesn't count hidden transactions ~ Productions hidden from government authorities, either because ‘those engaged in it are evading taxes or because it Is illegal (drugs, gambling etc). Doesn't count non ~ market production - Nonmarket production and Non-economic contributors to well-being for example: health of a country’s citizens, education levels, political participation, or other social and political factors that may significantly affect well-being levels are ignored, Economic bads are not accounted for - Economic ‘bads’ for example: crime, pollution, traffic congestion etc which make us worse off are not considered in GDP. Volunteer work excluded - The volunteer work and services rendered without remuneration undertaken in the economy, even though such work can contribute to ing as much os paid work. ‘Things that contribute to economic welfare - Many things that contribute to our economic welfare such as, leisure time, fairness, gender equality, security of community feeling etc., Better of for preventing worse off - ‘The distinction between production that makes us better off and production that only prevents us from becoming worse off, for e.g. defense expenditures such as on police protection, Increased expenditure on police due to increase in crimes may increase GOP but these expenses only prevent us from becoming worse off. No reflection is made in national income of the negative impacts of higher crime rates. What is meant by Domestic Territory? Contact No, 9211122778 Page 1.1.7Answer In layman's language, domestic territory means the political frontiers of @ country. In addition to political frontiers, domestic territory also includes: 1, Ships and aircrafts owned and operated by normal residents between two or more countries. 2. Fishing vessels, oil and natural gas rigs and floating platforms operated by the residents of a country in the international waters where they have exclusive rights of operation. 3. Embassies, consulates and military establishments of a country located abroad. Domestic territory doesn't include - 1. Embassies, consulates and military establishments of a foreign country. 2. International organizations like UNO, WHO, etc. located within geographical boundaries of a country. Question 21: Differentiate between : 1. Factor Income and Transfer Income 2. Final Goods ond Intermediate Goods 3. Consumption Goods and Capital Goods 4. Domestic Income (NDPrc) and National Income (NNPr2) 5. Depreciation and capital loss 6, Personal Income and Private Income 7. Personal Income and National Income Factor Income and Transfer Income Final Goods and Intermediate Goods Contact No, 9211122778 Page 1.1.8Chapter-1, Unit-I: National Income Accounting By: CA Nitin Guru Noture They are included in both national [They are neither included in and domestic income. rational income nor in domestic income. Value addition They are ready for use by their |They are not ready for use, i.e. final users i.e. no value has to be added to the final goods some value has to be added to the intermediate goods. Production boundary They have crossed the production boundary. ‘They are still within the production boundary. Example, Milk purchased by households for consumption, car purchased as an investment. ‘Milk used in dairy shop for resale, coal used in factory for further producti Consumption Goods and ‘Satisfaction of Capital Goods ‘These goods satisfy human wants ‘Such goods satisfy human wanted human wants directly. So, such goods have direct | indirectly. So, such goods have demand. derived demand. Production capacity | They do not promote production |They help in raising production capacity. opacity. Expected life ‘Most of the consumption goods | Capital goods generally have an (except durable goods) have limited expected life. expected life of more than one year. Nature of concept Domestic Income and National Income It Is a territorial concept as it includes the value of final goods and services produced within domestic territory of @ country. It is a national concept as it includes the value of final goods and services produced in the entire world. Category of | It considers all producers within the |It considers all producers who are Producers domestic territory of the country. | normal residents of the country. NFIA ‘Tt does not include NFTA ‘Tt includes NFA Depreciation and Capital ‘Meaning Loss Tt refers to fall in the value of fixed assets due to normal wear and tear, passage of time or expected obsolescence. It refers to loss in value of the fixed assets due to unforeseen obsolescence, natural calamities, thefts, accidents, etc. Provision for loss Provision is made for replacement of assets as it is an expected loss. No such provision is made in case of ‘copital loss as it is an unexpected loss. Production process: Tt does not hamper the production process. Tt hampers the production process. Contact No, 9211122778 Page 1.1.9~— What does private income refer to? Fo Income from Property and Entrepreneurship accruing to Government Administrative Departments. Savings of Non-Departmental Enterprises: Private income refers to the income which accrues to private sector from all the sources within and outside ‘the country, Contact No, 9211122778 Page 1.1.10Chapter-1, Unit-I: National Income Accounting By: CA Nitin Guru within Domestic territory L from Rest of the ‘World (ROW) ¥ + within Domestic ‘rom Rest ofthe territory World (ROW) | ¥ + Question 23: What is the meaning of Personal Disposable Income? Explain National Disposable Income (Net and Gross). National Disposable Income (NDY) refers to the income which is available to the whole country for disposal National Disposable Income = National Income + Net indirect taxes + Net current transfers from rest of ‘the world Contact No, 9211122778 Page L111Chapter-1, Unit-I: National Income Accounting By: CA Nitin Guru National Disposable Income (NDY) = National Consumption Expenditure * National Savings Gross National Disposable Income, When depreciation is added to the net National Disposable Income, we get Gross National Disposable Income. Gross National Disposable Income = Net National Disposable Income + Depreciation National Income 4 (+) Net Indirect Taxes (+) Net Current Transfers from rest of the world Net National Disposable Income + (+) Depreciation Gross National Disposable Income Give formulae for determination of Nominal GDP and Real GDP. ‘Answer: The formulae are as follows: Nominal GDP and Real GDP can be determined in the following manner: Real GDP = X2HHIEOF 109 Nominal 6p? = Hse trie nter ‘Question 26: Explain GDP Deflator (or Price Index). Answer: ‘The concept is explained as follows: GOP deflator measures the average level of prices of all the goods and services that make up GDP. GOP Deflator (or Price Index) = Someta x 109 Contact No, 9211122778 Page 1.1.12Chapter-1, Unit-I: National Income Accounting By: CA Nitin Guru Contact No, 9211122778 Page 11.13ICHAPTER 1: UNIT-II: THE KEYNESIAN THEORY _OF| IDETERMINATION OF NATIONAL INCOME} Who first explained determination of equilibrium income and output. The factors that determine the level of national income and the determination of equilibrium aggregate income and output in an economy. British economist John Maynard Keynes in his masterpiece ‘The General Theory of Employment Interest and ‘Money’ published in 1936, Explain circular flow in a simple two sector model, Two sectors in the economy viz., households and firms. Households own all factors of production and they sell their factor services to eam factor incomes ‘The business firms are assumed to hire factors of production from the households: they produce and sell goods and services to the households. ‘The government sector does not exist The economy is a closed economy, i.e., foreign trade does not exist; there are no exports and imports and external inflows and outflows National income equals the net national product Contact No, 9211122778 Page 1.2.1Chapter-1, U the Keynesian Theory By: CA Nitin Guru Question 3: Define equil ‘Aesiee ‘+ Equilibrium’ (defined as a state in which there is no tendency to change: or a position of rest) ‘+ Equlbrium output cccur when the desired amount of output demanded by all the agents in the economy exactly equals the amount produced in a given time period. + An economy can be said to be in equilibrium when the production plans of the firms and the expenditure plans of the households match. Explain the aggregate demand function: Two sector model ae In a simple two-sector economy aggregate demand (AD) or aggregate expenditure consists of only two components: © cagregate demand for consumer goods (C), and (i) aggregate demard for investment goods () ‘The short-run aggregate demand function can be written as: AD= Cel Where 1 = constant investment. Explain the consumption functi ‘Answer 1. Consumption function expresses the functional relationship between aggregate consumption expenditure ‘and aggregate disposable income, expressed as: c=tM) 2. The positive relationship between consumption spending and disposable income is described by the consumption function. 3. According to Keynes, the total volume of private expenditure in an economy depends on the total current disposable income of the people and the proportion of income which they decide to spend on ‘consumer goods and services. Consumption function, proposed by Keynes is as follows: Czarby Where C = aggregate consumption expenditure; ¥ = total disposable income; a is a constant term, value of consumption at zero level of disposable income: and b is the marginal propensity to consume cmc). Contact No, 9211122778 Page 12.24. . When income is low, consumption expenditures of households will exceed their disposable income and households dissave. 5. The Keynesian assumption is that consumption increases with an increase in disposable income, but ‘that the increase in consumption will be less than the increase in disposable income Explain Marginal Propensity to Consume (MPC). ‘The concept of MPC describes the relationship between change in consumption (AC) and the change in income (AY). The value of the increment to consumer expenditure per unit of increment to income is termed the Marginal Propensity to Consume (MPC). wees 20 sb MPC tends to decline at higher income levels. Question 7: Explain Average Propensity to Consume (APC). The ratio of total consumption to total income is known as the average propensity to consume (APC). : uae Contact No, 9211122778 Page 123Explain Savings Function (Propensity to Save). ‘+ Saving is also a function of income, i.e., saving also depends upon the level of income. ‘= Saving is the excess of income over consumption expenditure ‘+ Saving function refers to the functional relationship between saving and national income s=#M Where, S= Saving, ¥ = Notional Income, f = Functional Relationship ‘+ Saving function or Propensity to save, shows the saving of households at a given level of income during a given time period Important observations from Saving Schedule and Saving Curve: > Starting Point of Saving Curve: Savings Curve (SS) starts from point $ on the Y-axis, indicating that there is negative saving, when National Income is zero. > Slope of Saving Curve: SS has a positive slope, which indicates the positive relationship between saving and income. > Break-Even Point (5:0): Saving curve crosses the X-axis at a point which is known as breck-even point as at that point, savings is zero. > Positive saving: After the Break-even Point, saving is positive. Contact No, 9211122778 Page 12.4Explain the Marginal Propensity to Save (MPS). Comparison between APS and MPS Explain Investment Function. ‘Answer: ‘+ Thvestment refers to the expenditure incurred on creation of new capital assets. ‘+The investment expenditure is classified under two heads: (0 Trduced Zavestment (i) Autonomous Investment ‘+ Induced Investment: It refers to investment which depends on the profit expectations and is directly influenced by income level Induced Income vs Autonomous Trvestment Contact No, 9211122778 Page 12.5Explain The Two-Sector Model Of National Income Determination, ‘The two-sector model of determination of equilibrium levels of output and income in its formal form using the ‘aggregate demand function and the aggregate supply function @ ‘According to Keynesian theory of income determination, the equilibrium level of national income is a situation in which aggregate demand (C+ T) is equal to aggregate supply (C + 5) i.e C+rsCeSor T= Ina two sector economy, the aggregate demand (C+ T) refers to the total spending in the economy i.e. it is ‘the sum of demand for the consumer goods (C) and investment goods (X) by households and firms respectively. ap ‘The saving schedule S slopes upward because saving varies positively with income. In equilibrium, planned investment equals saving ‘+ Corresponding to this income, the saving schedule (S) intersects the horizontal investment schedule @. ‘+ At the equilibrium level of income, saving equals (planned) investment. ‘+ The equality between saving and investment can be seen directly from the identities in national income ‘accounting veces: veCer Contact No, 9211122778 Page 1.2.6+ The two together, we have C+ S=C+T, or S=T. ‘+ An important point to remember is that Keynesian equilibrium with equality of planned aggregate expenditures and output need not take place at full employment. ‘+ Output will remain at less than the full employment rate as long as there is insufficient spending in ‘the economy, Note: A steeper aggregate demand function—as would be implied by a higher marginal propensity to consume— implies a higher level of equilibrium income. Equilibrium by Saving and Investment Approach Explain the concept of Investment Multiplier. ‘Arswier ‘+ The concept of Investment Multiplier is an important contribution of Prof. J.M. Keynes + Keynes believed that on initial increment in ivestment increases the final income by many times, Multiplier expresses the relationship between an initial increment in investment ond the resulting increase in aggregate income. ‘+ Multiplier shows how many times the income increases os a result of on increase in investment, ‘+ Multiplier (K) is the ratio of increase in National Income (AY) due to an increase in investment (A). k= AY/ AT ‘+ Suppose an additional investment (AI) of Rs. 4,000 creres in on economy generates an additional income (AY) of Rs. 16,000 crores. K = 16,000 / 4,000 = 4 ‘+ The concept of Multiplier is based on the fact that one person's expenditure is another person's income. When investment is increased, it also increases the income of people + Incase of higher MPC, people will spend a large proportion of their increased income on consumption ‘+ In case of low MPC, people will spend lesser proportion of their increased income on consumption k=1/(- mec) Contact No, 9211122778 Page 1.2.7Formula of Multiplier (K) Ke Av/AL @ K=1/(1- MPC) REL / MPS ‘+The maximum value of multiplier is infinity, when the value of MPC is 1, Minimum Value of Multiplier: * The minimum value of multiplier is 1, when the value of MPC is zero. Working of Multiplier: ‘One person's expenditure is another person's income. When an additional investment is made, then income inereases many times more than the increase in investment. ‘+ Suppose. an additional investment of Rs.100 crores (AI) is made. + TF MPC is assumed to be 0.90, then recepients of this additional income will spend 90% of Rs.100 ‘+ Tn the next round, 90% of the additional income of Rs.90 crores, i.e.. Rs.81 crores will be spent on consumption and the remaining amount will be saved. ‘+ This multiplier process will go on and the consumption expenditure in every round will be 0.90 times of ‘the additional investment. Contact No, 9211122778 Page 12.8Explain Determination Of Equilibrium Income: Three Sector Model. Answer: ‘Aggregate demand in the three sector model of closed economy (neglecting foreign trade) consists of three components namely, household consumption(C), desired business investment demand(Z) and the government sector's demand for goods and services(6). Thus in equilibrium, we have Y = C+I+6 ‘+ GDP and national income are: equal ‘+ As prices are assumed to be fixed, all variables are real variables and all changes are in real terms ‘+ Each of the variables in the model is a flow variable. Contact No, 9211122778 Page 12.9‘+ The variables measured on the vertical oxis are ¢, T and 6. The autonomous expenditure components namely, investment and government spending. = C+ +6 schedule lies above the consumption. ‘+ The line S + T in the graph plots the value of savings plus taxes. This schedule slopes upwards because saving varies positively with income. ‘+ The equilibrium level of income is shown at the point E 1 where the (C + | + 6) schedule crosses the 45° line, and aggregate demand is therefore equal to income (¥). ‘+ In equilibrium, it is also true that the (S + T) schedule intersects the (I + 6) horizontal schedule, Explain Determination Of Equilibrium Income: Four Sector Model ‘= The four sector model includes all four macroeconomic sectors, the household sector, the business sector, the government sector, and the foreign sector. ‘+ The foreign sector includes households, businesses, and governments that reside in other countries. In the four sector model, there are three additional flows namely: experts, imports and net capital inflow which is the difference between capital outflow and capital inflow. The C+T+6+(X-M) line indicates the totel planned expenditures of consumers, investors, governments, and foreigners (net exports) at each income level. YeCer+ G+ (eM) + Exports are the injections in the national income, + imports act as leakages or outflows of national income Contact No, 9211122778 Page 1.2.10+ Equlibrium is identified as the intersection between the C+ I+ 6 + (X - M) line ond the 45-degree line. ‘+ The equilibrium income is Y. The leakages(S+T+M) are equal to injections (I+6+X) only at equilibrium level of income + Tf net exports ore positive (X > M), there is net injection and national income increases. + Tf XeM, there is net withdrawal and national income decreases. + When the foreign sector is included in the model (assuming M > X), the cggregate demand schedule C+I+G shifts downward with equilibrium point shifting from F to E. ‘+The inclusion of foreign sector (with M > X) causes a reduction in national income from YO to Y1. ‘+ Equilibrium income is expressed as a product of two terms: AY = k ‘+ the level of autonomous investment expenditure and the investment multiplier. ‘+ The autonomous expenditure multiplier in a four sector model includes the effects of foreign ‘transactions and is stated as 1 / (1~bex), where v is the propensity to import which is greater than ‘+ The multiplier in a closed economy is 1 / (1-B). 1. The greater the value of v, the lower will be the autonomous expenditure multiplier. The more open an ‘economy is to foreign trade, (the higher v is) the smaller will be the response of income to aggregate demand shocks, such as changes in government spending or autonomous changes in investment demand. ‘+The higher the value of v, larger the proportion of this induced effect on demand for foreign, not domestic, consumer goods. Contact No, 9211122778 Page 1.2.11Chapter-1, U hhe Keynesian Theory By: CA Nitin Guru + Consequently, the induced effect on demand for domestic goods and, hence on domestic income will be smaller ‘+The increase in imports per unit of income constitutes an additional leakage. 2. An increase in demand for exports of a country is an increase in aggregate demand for domestically produced output and will increase equilibrium income. Tf the demand for a country’s exports has an expansionary effect on equilibrium income, whereas an ‘autonomous increase in imports has a contractionary effect on equilibrium income. Contact No, 9211122778 Page 1.2.12I: FISCA > Steps taken By Government To control the potential rise in prices: To bring in welfare sections © Crop worry © fortified mid ~ + Rate Cut + Spend money or > i is ie variabl * To direct them to function in particular directions * Certain goods and services are provided exclusively by the > Types of Economic System =e >» Need conomic © To solve the problem of scarcity * To answer the basic questions such as what, how and for ¥ > Role of Government as advocated by Adam Smith. + Resource allocation role for government in national defenc maintenance of highly beneficial public institutions and pub! » ‘The Theory of Public Finance'(1959), introduced the three bri erged rer) : Contact No. 9211122778By: CA Nitin Guru FUNC Ns: AN OVERVIEW to the underprivileged | To incentives for the prot ______| of preduction/use of resources day © subsidize Smart phones ‘rural jobs * No tax on credit, debit card transactions up to Rs. 2,000 government. eT) +, co vhom to produce and how many resources should be used. , maintenance of justice and the rule of law, establishment and lic works. anch taxonomy of the role of government in a market economy. eed Corns Were Maou) Sera Page 2.1.1: ‘iscal Functions: An Overview Chapter-2, Uni Functions of Allocatio ti © It aims to correct the sources of inet icier MICROECONOMIC FUNCTIONS * It aims at fair distribu wealth and income. ributi ion (Fai > AT Define, Problem of Resource | Market Allocation rational * available factors of | « Imperfect competition |+ suit production are! and presence of |_— For allocated among the | monopoly @ various uses. Failure to —_ provide @) + Determines the | collective goods thre quantity actually to| + Externalities enfc be produced. + Factor immobility * G00 + Imperfect information that *Tnequalities in the | — mar istribution of income |+ Mer and wealth this + The com sub: >» Government failure + Government is not always infallible * Cost of measures > Cost of market failure. Governments may contribute to generate them. * Tnadequate information, conflicting objectives and administ + Not always be unbiased and benevolent. > Market economy leads to non - egalitarian because: * Distribution of income and wealth among individuals is likeh Intervention required to ensure a more desirable and just Contact No. 9211122778By: CA Nitin Guru ver it snes: Stabilization Function MACROECONOMIC FUNCTION tion of [+ It aims at maintenance of high levels of employment, price stability, the problems of macroeconomic stability, monetary and fiscal policy. lures ide the | Performance and various instruments le for Government of Government able corrective action | + Fiscal policy example: + Budgeting property rights: enforces contracts sugh provision of law arcement and courts. ds involving externalities © An optimum mix of various social goods (both public goods and merit goods). follows: tare not met by the |1. Production of Economic goods ket. 2. Influence private allocation ‘it goods also fall under |3. Competition/Merger policies purview. 4. Regulatory Activities government acts as a|5. Legal and —_ administrative plement rather than asa] frameworks stitute. 6. Mixture of--—_—intermediate techniques. rative costs. 1 to be skewed as few have istributic most of the wealth. Page 2.1.2Chapter-2, Uni ‘iscal Functions: An Overview Aims + For whom to produce. Equitable Distribution + Distribution to ensure | 2, Advancement of Well Being equity and fairness. of Deprived 3. Equality Security ‘Minimal Standard Of Living ss > STABILIZATION FUNCTIONS Definition ‘Need ‘Areas of We + Deliberate * Prolonged | + Labour employm stabilization instabilities capital utilizatic policies. * Stagflation | Overall output « © Eliminating * Contagion income, macroeconomic effect. * General price le fluctuations arising + The rate of ecc from suboptimal growth, and allocation. + Balance of inter payments. > Steps taken by government during’ Inflation 1. The government cuts down its expenditure or rai taxes, 2. Contractionary fiscal policy 3. Surplus budgets Contact No. 9211122778By: CA Nitin Guru Examples, ‘Two edged sword and its. solutions 1. Taxation Policies + Conflict between efficiency 2. Progressive taxes used for | and equity. financing public services, |» Efficiency costs or 3. Employment Reservations | __ deadweight losses. and preferences > Corrective measures are as 4. Regulation of manufacture | follows: and sale of —certain| * Optimal budgetary policy. products + Minimal efficiency costs 5. Special schemes for backward regions wk Two major components of Fiscal Policy policies important for Stabilization ‘ent and | 1, Overall Effect ~ Monetary policy. mn, Balance between} Controlling the size of and the resources and} money supply and expenditures interest rate. wels, Es . Fiscal policy mnomic Effect By means of By Specific Pol expenditure and ‘national taxation decisions. D ises| 1. The government increases its expenditure or cuts down taxes or adopts a combination of both. 2. Expansionary fiscal policy Page 2.1.3-Il: Market Failure Chapter-2, Uni > Market + Misallocation of scarce resources resulting in overproductie lure and its aspects 1. Demand side market failures: Demand curves do not take i 2. Supply side market failures: Supply curves do not incorpori » Reasons for Market Failures > Social Cost ivate Cost + Exter * Private costs borne by individuals directly + External costs borne by third parties not directly invol > The problem of harmful externalities does not usually float uj + Producers of harmful externalities not known. Cause-effect linkages are so unclea Contact No. 9211122778By: CA Nitin Guru de nH nto account the full willingness of consumers to pay. ate the full cost of production. eens I Teron a neeerrel) much because:-Il: Market Failure Chapter-2, Uni Characteristics of Private Public Goods Private Goods Utility, Private Property Rights Rivalrous. Excludable: No Free Rider Problem Horizontal Summation of Individual Demand Curves. Rejection ‘Additional Costs Issues of fairness and justice tend to rise Efficiently allocated resources > ‘Theory of Publi is’ - Paul A el ‘Collective i in his path-breaking 1954 pap * A public good (also referred to as collective consumption g: Classification of goods Rivalrous @) Private goods food, clothing, cars Non-rivalrous © Club goods, cinemas, private parks, sotelt television Contact No. 9211122778By: CA Nitin Guru Public Goods Utility No direct payment Non = Rival in consumption Non - Excludable Indivisibility Vulnerable ‘Additional Resource cost is zero ver ‘The Pure Theory of Public Expenditure’ 20d or social good) is defined as one which all enjoy in common. @) Common resources such as fish stocks, forest resources, coal (0) te Pure public goods such as national defence Page 2.2.2Chapter- Unit-II: Market Failure ‘Impure goods «Hybrid goods that possess some features of both public an © Partially rivalrous or congestible. © Consumption reduces, but does not eliminate, the benefits ‘* Impure public goods also differ from pure public goods in t + The possibility of exclusion from the use of an impure publ 1, Elimination of Free Ridi 2. Controlled degree of congestion + Two broad classes of goods have been included in the stud Club goods: first studied by Buchanan 2. Variable use public goods; first analyzed by Oakland ar 1asi - Public goods (Mixed Goods + Mix of services from the provision of goods * Near public good i.e. all qualities of the private goods and * Chargeable + Some sold through markets and others being provided by g + Their markets are called incomplete markets and considere + Example - Vaccinations provide private benefits but also r with vaccinated person. Cot n_ Access Resources (or | res eS) + Special class of impure public goods which are non-excluda + Their consumption lessens the benefits available for others + Free of charge. * Sustainability threat. + “Tragedy of the commons’ occurs when rivalrous but non - world. + Examples of common access resources are fisheries, comm Global Public Goods * Widespread impact on different countries and regions, pop + WHO delineates two categories of global public goods nami 1. Final public good (outcomes), ¢.g. the eradication of po 2. Intermediate public goods, (contribute to the provision Contact No. 9211122778By: CA Nitin Guru id private goods. of others. ‘hat they are often excludable. ic good has two implications, ies related to impure public goods. wd Sandmo some benefits of public good. overnment, d as inefficiency and market failure. seduce the chances of others getting infected who are in contact ble and rivalrous. excludable goods are overused, to the disadvantage of the entire an pastures, rivers, sea, backwaters biodiversity etc. ulation groups and generations. ‘lio and of final public goods) e.9. International Health Regulations aimed Page 2.2.3.-Il: Market Failure Chapter-2, Uni ‘at stopping the cross-border movement of communicabl . Id Bank identifies five areas of global hit The environmental commons , Communicable diseases International trade, International financial architecture, and Global knowledge for development. + No mechanism (either market or government) to ensure an SPP > Free ride bles + ‘Benefiting from the actions of others without paying’. A free rider is a consumer or producer who does not pay f Public goods provide a very important example of market Tf every individual plays the same strategy of free ridi therefore, nothing will be provided by the market. Then, « There is no meaningful demand curve for public goods. >» Tf the rider problem cannot be solved, the followit 1. No public good will be provided in private markets 2. Private markets will seriously under produce public goods. Contact No. 9211122778By: CA Nitin Guru e diseases and thus reducing cross-border health risks. ch it seeks to address namely efficient outcome. ‘or a non - exclusive good in the expectation that others will pay. ailure. ing, the strategy will fail because nobody is willing to pay and 1 free ride for any one becomes impossible. outcomes are possible: Page 2.2.4> Need of Government interventions Efficient functioning of markets. Creation of the basic framework for fair and open competi Establishment of the ‘rule of law’, Government creates and protects property rights. Framed competition and consumer law framework. The governments adopt various intervention mechanisms to Ca BC Contact No. 9211122778ot Market Failure By: CA Nitin Guru ENT INTER NS TO Tams ‘tive markets. ensure greater welfare of the society as follows: ora x eee Pe ad K Peta! Page 2.3.1Chapter-2, Unit-III: Government Intervention to Corre > Government intervention to minimize Market Power. + Market power exercised either by seller or buyer (@) Higher prices than competitive prices. (b) Restricts output and leads to deadweight loss. (©) The government intervenes as follows: . Competition Laws, e.g. the Competition Act, 2002 ete Exceptions e.g. patent and copyright laws grant exclusi Price Regulations e.g. electricity, gas and water supplie Rate of Return Regulation Setting Price Caps Peer S » Government Intervention to correct Negative Externalitie: A. DIRECT CONTROLS They openly regulate the actions of those involved in generatir 1. Prohibitir ecific activities that explicitly create jatiw 2. Passing laws to alleviate the effects of negative externali ‘Act, 1986. 3. Charging an emission fee 4. Forming Special bodies for instance the Ministry of Enviror B. MARKET-BASED POLICIES + They operate through price mechanism to create an incent Contact No. 9211122778ct Market Failure By: CA Nitin Guru ive rights of products or processes. ts. laces. ties For example, India has enacted the Environment (Protection) ament & Forest, ive for change. Page 2.3.2Chapter-2, Uni 1. Pollution Tax Market Out: 2. Cap - Trade System (also known as Tradable Emissions Per (a) These are marketable licenses to emit limited quantitie (b) India is experimenting with cap-and-trade in the fort the form of a cess on coal. Problems in administer icient pollution tax ‘cult to determine and administer Use of complex and costly administrative procedures Does not provide any genuine solutions Shift the tax burden Negative consequences on employment and investments i Tradabl. + The advantages of Tradable Permits are as follows: + Flexibility and efficiency * Cheap and simple + Incentives for innovation + Lower prices The disadvantages of Tradable Pe: follows: Only provide an incentive but does ik ey stop poll: Higher prices to consumers. gaene * Contact No. 9211122778ct Market Failure By: CA Nitin Guru mes of Pollution Tax mits) of pollutants and can be bought and sold by polluters. n of Perform, Achieve & Trade (PAT) scheme and carbon tax in ution.Chapter-2, Uni -III: Government Intervention to Corre: > Government Intervention to correct Positive Externalities. As 2 3, Subsidy ct entry by the Government Direct production of Environmental Quality > Government Intervention in the case of Merit Goods. as ime ab 4. Regulation - For example, the way in which education is to Subsidies - For example subsidy for windmill or solar panel ct Government Pro} Combination of Government Provi ‘and Market Provision > Reasons for government provision of Merit goods, i. ey a 4. Loss of Social Welfare Information Failure Equity Considerations Uncertainty >» Government Intervention in the case of Demerit Goods. A Steps taken By Government Complete Ban Persuasion Legislations Limitations on Access Regulatory Controls High taxes Fixing Minimum Price USPS PP Contact No. 9211122778Market Failure By: CA Nitin Guru be imparted is government regulated. I. Page 2.3.4-III: Government Intervention to Corre: Chapter-2, Uni B. Limitations 1. The demand is often highly inelastic. 2. Additional taxation and shift of the taxes to consumer 3. Stringent regulation resulting in goods traded in a hidd » Government Intervention in the case of Public Goods 1, The non-rival nature of consumption provides a strong argu (@) Pure public goods (b) Excludable public goods 2. Governments grant licenses to private firms to build a publ 3. Certain goods are produced and consumed as public goods > Price Intervention by Government + Price interventions are legal restrictions on price. + The Price interventions of the government are as follows: 1. Price controls may take the form of: @ floor (a minimum price buyers are required to (©) Price ceiling (a maximum price sellers are allowed t _ ~ Examples of such market intervention are fixing ¢ 2. Intervention in Primary markets (@) For example in India, Minimum Support Price (MSI the set support prices. Market Outcome Contact No. 9211122778ct Market Failure By: CA Nitin Guru s. en market. iment for the government to provide: ic good facility. ind services Pay); or > charge for a good or service). vf minimum wages and rent. P) programme as well as procurement by government agencies at of Minimum Support PriceChapter-2, Unit-III: Government Intervention to Corre (©) Price ceilings (also called maximum price) Marke (c) Maintenance of buffer stocks > Government Intervention for Correcting Information Failure 1, Accurate labeling and Content Disclosure 2. Public Dissemination of Information 3. Regulation of Advertising > Government Intervention for Equitable Distribution. progressive income tax, targeted budgetary allocations, unemployment compensation, transfer payments, subsidies, social security schemes, job reservations, land reforms, gender sensitive budgeting etc. PEAR ee + Government also intervenes to combat black economy and n > Government failure occurs when: + interventior fective * intervention produces fresh and more serious problems Contact No. 9211122778ct Market Failure By: CA Nitin Guru + Outcome of Price Ceiling rarket distortions associated with a parallel black economy.Chapter-2, Uni » Objectives of Fiscal Policy Vary from country to country. The most common objectives of fiscal policy are: (@) Achievement and maintenance of full employment, (b) Maintenance of price stability, (©) Acceleration of the rate of economic development, and (d) Equitable distribution of income and wealth, For instance, while stability and equality may be the pr equity may get higher priority in developing countries. > Automatic Stabilizers and Discretionary Fiscal Policy. A * B. Automatic Stabilizers (Non-discretionary fiscal policy) Definition + ‘Bui ‘iscal mechanisms that operate automatically © Any government programme that automatically tends to + Tendency for increasing GDP when it is falling and red. «Examples - Personal income taxes, corporate income t: benefits). Automatic Stabilizers occur es‘followsiduringt (a) Recession 1. Reduction in income, less taxes and refunds. 2. Increase in Government expenditure. 3. Limiting the decrease in disposable income during + contraction phase. Discretionary Fiscal Policy % Deliberate policy actions on the part of government: + to change the levels of expenditure, * taxes to influence the level of national output, employment and prices Contact No. 9211122778By: CA Nitin Guru V: FISCAL POLICY| iorities of developed nations, economic growth, employment and «reduce fluctuations in GDP is called an automatic stabilizer. icing GDP when it ng. axes and transfer payments (unemployment compensation, welfare (©) Expansion 1. Increase in income and taxes lead to less disposable income resulting in decline in consumption and aggregate he demand. 2. Higher corporate taxes and lower surplus cause decline in consumption and investment. 3. all types of incomes rise and the amount of transfer payments decline. Page 2.4.1Chapter-2, Unit-IV: Fiscal Policy ° infil if * changing the level and types of taxes, * the extent and composition of spending, * the quantity and form of borrowing. % Governments may directly as well as indirectly influenct * It is evident from the equation that governments car influencing C, I, and NX indirectly, through changes in > Instruments of Fiscal Policy PS ey —————— Ce eid > Government Expenditure as an Instrument of Fiscal Policy. ‘A. Public Expenditure * Income generating and include all types of government’ expenditures etc. + Tt includes governments’ expenditure towards consumpti B. Government expenditure Government expenditure include: 1. Current expenditures 2. Capital expenditures 3. Transfer payments C. Government expenditure during Recession 1. Steps taken by government * Directly generate incomes to labour and suppliers o * Indirect effect in the form of working of multiplier * Induce secondary and tertiary employment. Contact No. 9211122778By: CA Nitin Guru 2 the way resources are used in an economy. 1 influence economic activity (GDP) by controlling G directly and taxes, transfer payments and expenditure. Cmte clio Cee os t expenditure such as capital expenditure on public works, relief li jon, investment, and transfer payments. F materials and services.Chapter-2, Unit-IV: Fiscal Policy 2. The two concepts of public spending during depression (a) Pump Priming * One-shot injection of government expenditure into depressed economy. + Permanent recovery from a slump. 3. Public Expenditure used as Policy Instrument * To reduce the severity of inflation by reducing govern * Reduced incomes on account of decreased public spendi » Taxes as an Instrument of Fiscal Policy. Overview During 1, For establishing stability. 1. To encourage 2. Encouraging or restricting private and investment expenditures on consumption and | 2. Low corporate investment. prospects of pr 3. Determine the size of disposable} promote furthe income. > Public Debt as an Instrument of Fiscal Policy. (From its Own people) > Public debt takes two forms: ‘Market loans + Govt. issues treasury bills and government securities of varying denominations and duration. + For capital projects - Long term capital bonds + For short term expenditures - treasury bills Contact No. 9211122778By: CA Nitin Guru (b) Compensatory Spending a| + Government spending is deliberately carried out with the obvious intention to compensate for the deficiency in private investment. nent expenditure. hg helps to eliminate excess aggregate demand. Recession During Inflation private consumption |1. New taxes and existing taxes are raised. taxes increase the |2. Excessive taxation usually stifles new cofits for business and investments. ar investment. (From Outside Sources) ‘Small savings * Not negotiable and are not bought and sold in the market. * National Savings Certificates, National Development| Certificates are few examples. * Borrowing from the public curtails the aggregate demand, * Repayments by governments increase the availability of money in the economy and increase aggregate demand. Page 2.4.3Chapter-2, Uni Fiscal Policy » Budget as an Instrument of Fiscal Policy. * A statement of revenues earned from taxes and other sou Balanced Budget Surplus Buda + Expenditures = Revenues Expenditures < Revenues + No net effect on|+ Negative net effect on aggregate demand since leakages exceed in + Anation's debt is the difference between its total past de > Types of Fiscal Policy. A budget surplus reduces government debt, increases savin Higher levels of domestic savings decrease international bo (eB Particulars EXPANSTONARY When is this policy | At the time of Recession needed? How does the government uses this policy? Real GDP at Y1 level lies level, 2. Contact No. 9211122778By: CA Nitin Guru rces and expenditures made by government in a year. st Deficit Budget aggregate demand + Expenditures > Revenues * Positive net effect on aggregate demand since total injections exceed leakages. ficits and its total past surpluses. 'gs and reduces interest rates. rowings and lessen the current account deficit. ' POLICY CONTRACTIONARY POLICY ‘At the time of Inflation below the natural + Contractionary policy measures so that The aggregate demand curve (AD) shifts to the left and the equilibrium may be established at the full employment level of real GDP * This can be achieved e 1. Decrease in government spending 2. Increase in personal income taxes and/or business taxes 3. A combination of the above two measures Page 2.4.4Chapter-2, Uni Fiscal Policy * There are two views as follo, 1. Classical is % Reduction in wages cost: supply and the short run curve SAS1 will shift to t 2 and bring the economy bc full employment at ¥2. 2. Keynesian View % Wages are not much flexit downward,” + Increase in government ex a shift in the aggregate the right from AD 1 to AD 2. % As a response to the shi increases. 4 More output, and hiring mo The government uses a financed either through bot monetization. Note: Expansionary fiscal successful only if there i monetary policy. » Recessionary gap (Contractionary gap) + Existing levels of aggregate production < Levels of Aggregate + When the aggregate demand is not sufficient to create condit * Occurs during the contractionary phase of business-cycle and > Few examples of Fiscal Policy for long run economic + Fiscal policies such as those involving infrastructure spendii + When government supports building a modern infrastructur Contact No. 9211122778By: CA Nitin Guru us s would increase aggregate supply he right say SAS ack to the level of le and are ‘sticky ‘penditures causes demand curve to ift in AD, output re workers. deficit budget, “rowing or through policy will be is accommodative As real GDP rises above its natural level Y, prices also rise, prompting an increase in wages and other resource prices. + This causes the SAS curve to shift from SAS 1 to SAS 2. + Asa result, the price level goes up from P1toP3. * The real GDP remains the same at Y. * The government intervenes to control inflation by Contractionary fiscal policy, to reduce aggregate demand so that the aggregate demand curve (AD1) does not shift to AD2. * The government needs to reduce expenditures or raise taxes. production with full employment of resources. ions of full employment. results in igher rates of unemployment. ng generally have positive supply-side effects. ‘e, the private sector is provided with the requisite overheads it Page 2.4.5Fiscal Policy me needs. * Government provision of public goods such as education, economic growth. + Avwell designed tax policy that rewards innovation and enh businesses. Fiscal Policy reduces Inequalities of Income and Wealth. A few such measures to achieve desired distributional effects 1. Progressive Direct Tax System 2. Differential Indirect Taxes 3. Public Expenditure policy imitati iscal Poli 1. Existence of Different types of Lags There are different types of lags involved in fiscal-policy + (a) Recognition Lag (b) Decision Lag (©) Implementation Lag (d) Impact Lag Wrong timing icult to reduce Government Expenditure Non adjustment of Public works Forecasting Difficulties Conflicts in different Objectives Opinion of Supply side Economists . Perpetual Burden 10. Crowding out 11. Price Spiral Crowding out. Government spending replaces private spending, the latter is s PENOTAYN . For example, if government provides free computers to st forthcoming. Fiscal policy becomes ineffective as the dec! resulting from an increase in government expenditure. During deep recessions, crowding-out is less likely to happen. private + Contact No. 9211122778By: CA Nitin Guru research and development etc. provide momentum for long-run repreneurship, without discouraging incentives will promote private are as follow: action as follows: aid to be crowded out. udents, the demand from students for computers may not be spending partially or completely offset the expansion in demand Page 2.4.6Chapter-3, Uni oncept of Money Demand > Definition of Money Assets which are commonly used and accepted as a mean: purchasing power. Purchasing Power «All Medium of exchange not Money Liquid Asset © No Intrinsic Value of Currency + Fiat Money © Electronic records > Money as per economic theory. In economic theory * Set of liquid financial assets + Tts stock variation could impact on aggregate economic activity. > Functions of Mot Convenient medium of exchange Unit of value or unit of account Unit or standard of deferred payment Store of value > General characteristics of money ‘Money should be: + generally acceptable © durable or long-lasting + effortlessly recognizable. «© difficult to counterfeit ily reproducible by peop + relatively scarce, but has elasticity of supply + portable or easily transported ‘+ possessing uniformity; and + divisible into smaller parts in usable quantities or fractions eee e. not e: Contact No. 9211122778By: CA Nitin Guru CEPT OF MONEY DEMAI + of payment or as a medium of exchange or of transferring _| Asa statistical concept ‘Money could include certain liquid ies of a particular set of financial intermediaries or other issuers’,(Reserve Bank of India Manual on Financial and Banking Statistics, 2007). without losing value Page 3.1.1oncept of Money Demand » The demand for money 1. Desire to hold money 3. Role of Money 4. Holding Money 5. Opportunity Cost » Classic Thee Der Mone lantity Th by it ‘isher * There is strong relationship between money and price level + _ Also called ‘equation of exchange’ or ‘transaction approach’ Where, M= the total amount of money in circulation (on an average) in an economy V= transactions velocity of circulation i.e. the average number of times across all transactions a unit of money(say Rupee) is spent in purchasing goods and services P = average price level (P= MV/T) T = the total number of transactions. + Later, Fisher extended the equation of exchange to include demand (bank) deposits (M') and their velocity (V') in the total supply of money as follows: Where, M’ = the total quantity of credit money V" = velocity of circulation of credit money. Contact No. 9211122778By: CA Nitin Guru ch) > ‘The Neo Classical Approach (The Cat Tal |___Demond forMoney, 0 > Money increases utility in the following two ways: 1. enabling the possibility of split-up of sale and purchase to two different points of time (transaction motive), and being a hedge against uncertainty (temporary store of wealth) + Also called Cash Balance Approach Where, M@ = is the demand for money Y = real national income erage price level of currently produced goods and services nominal income proportion of nominal income (PY) that people want to hold as cash balances 2 Page 3.1.2Chapter-3, Uni oncept of Money Demand » The Keynesian Theory o: for_ Money (Liquidity Prefer: + People hold money (M) in cash for three motives: 1, Transaction Motive: The need for cash arises because there i: + The transactions demand for money is a direct proportiona Where Lr, = the transactions demand for mor k = ratio of earnings which is kept { Y= the earnings Precautionary Motive: Everyone keeps a portion of their incom . Speculative Motive: It reflects people's desire to hold cash expenditure. There can be three cases as follows: Case A: When (rn > re) i.e. rise in bond prices, then they wi Case B: When (rnére) i.e. fall in bond prices, then they woul cash rather than bonds. Case C: When rn = rc, then they will be indifferent to holdin «The speculative demand for money of individuals can be dic on + The speculative demand for money and current rate of int« Contact No. 9211122778By: CA Nitin Guru 2nce Theory’) 3 lack of synchronization between receipts and expenditures. Land positive function of the level of income as follows: rey, ‘or transactions purposes e to finance such unanticipated expenditures. to invest in any attractive investment opportunity requiring cash Il convert their cash balances into bonds d have an incentive to hold their wealth in the form of liquid g either cash or bonds. grammatically presented as fc IS: arest are inversely related as shown below Page 3.1.3> Pe Si ir Inventory Approach __to Transact] Balances (Deterministic The: oncept of Money Demand Friedman's Restateme Theory + By Boumol and Tobin + By Milton Fredman > Money or ‘real cash balance’ as an inventory held for _ transaction purposes. + Demand for money i 1.Permanent income. 2.Relative returns incorporate risk) + Inventory models assume that there are two media for storing value: 1. money and 2. an interest-bearing alternative financial asset. + People hold an optimum combination of bonds and cash balance. + Excess cash will be invested in bonds or put in an interest - bearing account. * Friedman identifies determinants of the | The nominal demand: 1. isa function of t 2. is positively rel level, 3. rises if the of money holdings (i and stock) decline is influenced by it Contact No. 9211122778By: CA Nitin Guru ™ mt of the Quantity The Demand for Money as Behavior toward Risk Tobin in ‘Liquidity Preference as Behavior towards Risk’ s affected by : on assets. (which Provided the foundation for the liquidity preference and for a negative relationship between the demand for money and the interest rate. the _followi ‘our, demand for money. for money? otal wealth, ated to the price sportunity costs of .e. returns on bonds : and vice versa. aflation, * The optimal portfolio structure is determined by ()the risk/reward characteristics of different assets (i) the taste of the individual in maximizing his utility consistent with the existing opportunities «rational behaviour of a risk-averse economic agent holds an optimally structured wealth portfolio which is comprised of both bonds and money Page 3.1.4+ Total quantity of money available to the people. + Ibis important to note two things 1, Stock variable i.e. money available at any particular pe 2. Change in the stock of money. + The term ‘public’ includes all economic units (households, government and the banking system). > Rationale asuring Money Sut 1. Deeper Understanding 2 valuate >» Sources of Money Supply > re + Four alternative measures of money supply denoted by M1, «The respective empirical definitions of these measures are M1 is the most liquid and M4 is the least liquid of the fou * M1 is also called Narrow Money. Contact No. 9211122778By: CA Nitin Guru OF MONEY PLY| vint of time. firms and institutions) except the producers of money (i.e. the Credit Money (Responses of Commercial Banks to M2, M3 and M4 besides the reserve money. given below: measures.Chapter-3, Unit-II: Concept of Money Supply M1 includes the demand deposits and reserve money in Reserve money is also known as central bank money, be The central bank also measures ‘liquidity’ aggregates in Close substitutes of money issued by the non-banking ¢ SAAN » terminant: There are two alternate theories in respect of determination : ¥ First View: Money supply is determined exogenously by the + Second View: Money supply is determined endogenously | central bank, the commercial banks and the public. Contact No. 9211122778By: CA Nitin Guru cludes the cash reserves of banks. tse money or high-powered money. addition to the monetary aggregates. ‘inancial institutions are also included. of money supply. : Central bank, ay changes in the economic activities i.e.joint behaviour of the Page 3.2.2Unit-II: Concept of Money Supply > Money Multiplier ‘© The money supply is defined os ‘Mis the money supply, m is money multiplier and MB is + From the above equation we can derive the money multiplie Where, + Aratio that relates the changes in the money supply to a > ‘The Money Multiplier Approach to Supply of Money. * The money multiplier approach to money supply propoundec ‘actors as immediate determinants of money supply, namel (i) the stock of high-powered money (H) i.e. Behaviour of (i) the ratio of reserves to deposits, e = (ER/D} i.e. behe (ii) the ratio of currency to deposits, ¢ ={C/D} i.e. behavi () Behaviour of Central Bank + Supply of the nominal high-powered money. + If the behaviour of the public and the commercial t money in the economy will vary directly with the supply (O} Serpe The behaviour of the commercial banks in the economy + There are two cases, where required reserve ratio ch, Case A ~ Required Reserve ratio increases, more reser’ Case B - Required reserve ratio falls, there will be ext + The banking system's excess reserves ratio is negative (ii) Behaviour of Public + The behaviour of the public influences bank credit thn as the ‘currency ratio’. * Currency in public hands causes multiple expansi * Money multiplier and the money supply are nega + An increase in TD/DD ratio means that greater avail deposit expansion and monetary expansion. Contact No. 9211122778By: CA Nitin Guru the monetary base or high powered money. (mm) as given change in the monetary base. iby Milton Friedman and Ant hw (1963) considers three & Central Bank wiour of Commercial Bank our of Public vanks remains unchanged over time, the total supply of nominal of the nominal high-powered money issued by the central bank. is reflected by Reserve Ratio. anges and other variables remain same as follows: ves would be needed. vansions of deposits ly related to the market interest rate. ough the decision on ratio of currency to the money supply known on to decline, and therefore, money multiplier also falls. tively related to the currency ratio c. ability of free reserves and thus increase in volume of multipleChapter-3, Unit-II: Concept of Money Supply > The effect of Government Expenditure on Money Supply. * The excess reserves created because of lending by RBI through the money multiplier process > The Credit Multiplier (the deposit multiplier or the deposit ex © How much new money will be created by the banking syste! © Bank's ability to increase the money supply. ‘© The credit multiplier is the reciprocal of the required rese Credit Multiplier = > Are Deposit multiplier and money multiplier same? © The deposit multiplier and the money multiplier though clos a) Generally banks do not lend out all of their available mo required reserve. 2) All borrowers do not spend every Rupee they have borrowe Contact No. 9211122778By: CA Nitin Guru to government, potentially lead to an increase in money supply Required Reserve Ratio ely related are not identical becaus ney but instead maintain reserves at a level above the minimum :d. They are likely to convert some portion of it to cash. Page 3.2.4Unit-Il Chapter- Monetary Policy HAPTER » Monetary Policy + the use of a icy instruments to regulate (a) the availability, cost and use of money and credit to pr (©) price stability, (©) optimum levels of output and employment, (d) balance of payments equilibrium and stable currency et «all actions of the central bank aimed at: (@) directly controlling the money supply and; (b) indirectly > Monetary Policy Framework A, The Objectives of monetary policy 8, The Analytics of which focus on th mechanisms 1. General Objectives are as follows: (@) Balance between price stability and economic growth. (©) rapid economic growth, (©) debt management, (d) moderate long-term —_ interest rates, (e) exchange rate stability (A) external balance of payments equilibrium The process or che the change of n affects the level of known as “mont mechanism’. 2. The monetary policy of Developi countries has objectives of (a) Economic growth, (b) Adequate flow of credit to the productive sectors, (c) sustaining - a moderate structure of interest rates (A) creation of an efficient market for government securities. Four different mec (a) The interest rate (b) The exchange ra’ (©) The quantum che money supply and ¥ Two distinct che (d) The asset price and real estate Contact No. 9211122778By: CA Nitin Guru MONETARY PO! somote economic growth, at regulating the demand for money. monetary policy sas C, The Operating procedure which jing te instruments innels through which yonetary aggregates product and prices is etary transmission * day-to-day implementation of monetary policy. hanisms are: channel te channel mnel_(e.9., relating to credit) annels_under_quantum ling channel +heet channel channel i.e, via equity ices + The direct instruments comprise of: (a) Cash reserve ratios and liquidity reserve ratios (b) Directed credit (©) Administered interest rates + The indirect instruments mainly consist of: (o) Repos () Open market operations (c) Standing facilities, and (@) Market-based discount window Page 3.3.1Chapter-3, Unit-III: Monetary Policy > Operating Framework, + All aspects of implementation of monetary policy. + It primarily involves three major aspects, as follows: 1. Choosing the operating target 2. ing the intermedi > Cash Reserve Ratio (CRR) and Monetary Policy Fraction of the total net demand and time liabilities (NDTI To be maintained as cash deposit with the Reserve Bank. Uniform to all scheduled banks. Does not apply to Non - Bank Financial Institution (NBFIs) The Reserve Bank does not pay any interest on the CRR bc Higher the CRR, lower will be the liquidity and vice versa. During slowdown in the economy, the RBI reduces the CRR supply of money available in the economy. «The cash reserve ratio as on 16th February, 2020 was 4.( > Stat iquidity Ratio (SLR) and Monetary Poli + Prudential measure. + Stipulated percentage of their total Demand and Time Liat * Cash % Gold, or % Investments in un-encumbered Instruments that include (®) Treasury-bills of the Government of India. (0) Dated securities including those issued by the Gove (©) State Development Loans (SDLs) issued by State G (4) Other instruments as notified by the RBI SLR on 15" February, 2020 was 19%. A powerful tool for controlling liquidity. Influences the availability of resources in the banking syst During high liquidity period, SLR is raised. Provides a market for government securities. > Liquidity Adjustment Facili and M Policy + Central Bank (Bankers bank) provides liquidity to banks thr Contact No. 9211122778By: CA Nitin Guru -) of Bank. alances: in order to enable the banks to expand credit and increases the ) per cent. ies (DTL) / Net DTL (NDTL) in one of the following forms: rnment of India overnments em. ough its discount window. Page 3.3.2Chapter-3, Uni Monetary Policy v Banks can borrow from the discount window against the ce treasury bills, or other eligible papers. * From June 2000, the RBT has introduced Liquidity Adjustn + Following are under Liquidity Adjustment Facility (LAF). (Repurchase Option (REPO) + An instrument for borrowing funds by selling securitie agreed future date at an agreed price which includes it + Report on the electronic platform called the Negotiate: + The rate charged is called the ‘repo rate’. Repo operat + Tf the RBI wants to make it more expensive for banks REPO rate reported in February 2020 was 5.15% on raat e REPO. "Reverse Repo’ is defined as an instrument for lending securities on a mutually agreed future date at an agret + Reverse repo operation takes place when RBI borrows 1 + The interest rate paid by RBI for such transactions is + Reverse repo operation in effect absorbs the liquidity i + There are three types of repo markets operating in India namely (Repo on sovereign securities Repo on corporate debt securities ,and Other Repos 4 ‘Term Repo’ (repos of duration more than a day) is for 14 inal Standing Facility (MSF) and Monetary Policy? * RBI acts as a lender of last resort. + Scheduled commercial banks can borrow additional amount available to them through the LAF window by dipping into penal rate of interest. * Safety valve against unexpected liquidity. * Banks can borrow through MSF on all working days exce minimum amount which can be accessed through MSF is Rs. + The MSF rate was 5.65% in February, 2020. «MOU between the Reserve Bank of India (RBI) and the Go * The primary aim of aiding the sterilization operations of t Contact No. 9211122778By: CA Nitin Guru lateral of securities like commercial bills, government securities, rent Facility (LAF). s with an agreement to repurchase the securities on a mutually aterest for the funds borrowed’, 4 Dealing System (NDS) ‘ions thus inject liquidity into the system. to borrow money, it increases the repo rate. | funds by purchasing securities with an agreement to resell the ed price which includes interest for the funds lent. money from banks by giving them securities. called the ‘reverse repo rate’. n the system. days and 7 days tenors. of overnight money from the central bank over and above what is their Statutory Liquidity Ratio (SLR) portfolio up to a limit at a :pt Saturdays, between 7.00 pm and 7.30 pm, in Mumbai. The . 1 crore and more will be available in multiples of Rs. 1 crore. vernment of India (GOT). ye RBI. Page 3.3.3Chapter-3, Unit-III: Monetary Policy © Under this scheme, the Government of India borrows from excess liquidity from the market arising from large capital » Bank Rate and Monetary Policy * Bank Rate is the standard rate at which the Reserve Bar commercial paper eligible for purchase under the Act. «Used only for calculating penalty on default in the mainten >» Qpen Market Operations and Monetary Policy «Market operations conducted by the Reserve Bank of Indic market with an objective to adjust the rupee liquidity cond + When the RBI feels there is excess liquidity in the marke liquidity. f etary Poli isi I. The Policy Framework Agree! © Agreement reached between the Government of India anc the Reserve Bank of India (RBI) on the maximum tolerable inflation rate for price stability. Inflation targeting. * Once in every five years. Accordingly, Consumer Price Index (CPI) for the period from Augus: 5, 2016 to March 31, 2021 is 4% with the upper tolerance limit of 6 per cent and the lower tolerance limit of 2 per cent. Monetary Policy Report every six months is mandatory. v The following factors are notified: (a) the average inflation > the upper tolerance level (b) the average inflation < the lower tolerance leve < Contact No. 9211122778By: CA Nitin Guru \ the RBI and issues treasury-bills/dated securities for absorbing inflows. ak is prepared to buy or re- discount bills of exchange or other ance of CRR and SLR. by way of sale/ purchase of Government securities to/ from the litions in the market. +, it resorts to sale of securities thereby reducing out the rupee IE. The Monetary Policy Committee * Six-member Monetary Policy Committee (MPC) constituted in September, 2016 + determine the policy rate required to achieve the inflation target. ‘> The new system is intended to incorporate: diversity of views, specialized experience, independence of opinion, representativeness, and Y accountability. * Assisted by The Reserve Bank's Monetary Policy Department (MPD) * The Financial Markets Operations Department (FMOD) i operationalises the monetary policy. S488 Page 3.3.4Chapter-4, Unit-I: Theories of International Trade By: (CA Nitin Guru (CHAPTER 4: UNIT-I HEORIES OF INTERNATIONAL TRADE| > International Trade And the complexities involved ‘> Intemational Trade: ‘© Exchange of goods and services as well as resources between countries, ‘+ Transactions between residents of different countries. ‘+ Involves transactions in multiple currencies. > Complexities Involved: + heterogeneity of customers and currencies, differences in legal systems, more elaborate documentation, diverse restrictions in the form of taxes, regulations, duties, tariffs, quotas, trade barriers, standards, restraints to movement of specified goods and services and issues related to shipping cand transportation. > Arguments supporting International Trade. Economic efficiency and contribution to economic growth Cheaper raw material, new material and foreign exchange Increases the scope for mechanization and specialization Raising standards of livelihood ‘Trade strengthens bond between nations > Arguments against Trade Openness ‘= Unhealthy occupational environments ‘+ Not equally beneficial to all nations + Exhaustion of natural resources ‘+ Threat to domestic industries ‘+ Welfare of people may be ignored + Severe competition > The Mercantilists' view of International Trade. ‘of Europe's great powers) ‘= Based on increasing experts and collecting precious metals in return, ‘+ The more gold and silver a country accumulates, the richer it becomes. ‘+ Advocated maximizing exports and minimizing imports. + This view argues that trade is a ‘zero-sum game’, and one country's gain is equal to another country’s > The Theory of Absolute Advantage ‘+ International trade is not a zero-sum game Exchange of goods between two countries will take place only if each of the two countries can produce one commodity at an absolutely lower production cost than the other country. Principle of division of labour constitutes the basis for his theory of international trade. By specializing and trading freely, global output is maximized and more of both goods are available to ‘the consumers in both the countries. Contact No, 9211122778 Page 4.1.1> Even if one nation ls less efficent than (has on absolute dioodvontoge with respect fo) the other nation in the production of all commodities, there is stil scope for mutually beneficial trade. ‘+ Tis based on ‘labour theory of value’, which assumes that the value or price of a commodity depends exclusively on the amount of labour going inte its production. ‘+ The above assumption is quite unrealistic because there are other factors of production also. > Haberler’ Solutic ‘= Haberler introduced the opportunity cost concept from Microeconomic theory to explain the theory of comparative advantage in which no assumption is made in respect of labour as the source of value. + According to the opportunity cost theory, the cost of a commodity is the amount of a second commodity that must be given up to produce one extra unit of the finst commodity, ‘+ Opportunity Cost of Producing X = Labour required for 1 Unit of X/ Labour required for 1 Unit of ¥ factor-producti Note: international differences in rel are the cause of comparative advantage and a country exports goods that it produces relatively efficiently. > Limitations of Ricardian ‘+ Tts emphasis is on supply conditions and excludes demand pattern. + The theory does not examine why countries hove different costs. = The Inmodiate cause of inter-regional trade (s that goods can be bought cheaper hi terms of money ‘than they can be produced at home. Tf a country is a capital abundant one, it will produce and export capital intensive goods. ‘The Heckscher-Ohlin theory of foreign trade can be stated in the form of two theorems: “@ Hecscher-Ohin Trade Thearem |G) Facter- Pie Eqolzation Theorem + a country tends to specialize in the | + A corollary to the Heckscher-Ohlin trade theory. export of a commodity whose | + International trade tends to equalize the factor prices production requires intensive use of | between the trading nations. its abundant resources; and + Whichever factor receives the lowest price before two ‘+ imports a commodity whose | countries integrate economically and effectively become one production requires intensive use of | market, will therefore tend to become more expensive its scarce resources. relative to other factors. Contact No, 9211122778 Page 4.1.2Developed and big countries are trade partners when they are trading similar goods and services. ‘This is particularly true in key economic sectors such as electrenics, IT, food, and automotive NTT argues that, because of substantial economies of scale and network effects, it pays to export phones to sell in another country. Those countries with the advantages will dominate the market, ond ‘the market takes the form of monopolistic competition. ‘= According to NTT, two key concepts give advantages to countries that import goods to compete with products from the home country: Economies of Scale Network Effects: + As a firm produces more of a product its cost per unit |» The value of the product or service is keeps going down. So if the firm serves domestic as | enhanced as the number of individuals well as foreign market instead of just one, then it con | using it increases. recap the benefit of large scale of production |+ This is also referred to as the ‘bandwagon consequently the profits are likely to be higher. effect’. + Consumers like more choices, but they also want products and services with high utility, and the network effect offers increased utility from these products over others. + A good example will be Mobile App such as Whats App and software like Microsoft Windows. Contact No, 9211122778 Page 4.13Chapter-4, U The Instruments of Trade Policy By: CA Nitin Guru CHAPTER 4: UNIT-IT: THE INSTRI 'S OF TRADE POLICY > Trade Policy and its instruments + All instruments that governments may use to promote or restrict imports and exports. * The instruments of trade policy can be classified asi 1. Price= related measures such as tariffs, ond 2. Non-price measures or non-tariff measures (NTMs). > Tariff as Trade Policy Instrument and its various types. + Toriffs (Custom Dues) ‘+ Taxes or dues imposed on goods and services which are imported or exported, + _Import dues being pervasive than export dues, taritfs are often identified with import dues. ‘Ain, Forms of Inport Tariffs ‘Other variations of the these two sariffs, + Alter the relative | @) Specific Tariff: @) Mined Tariffs prices, so as to contract | + Assigns a fixed monetary tox | b) Compound Teriff or a Compound the domestic demand. per physical unit of the good | Duty + Regulate the volume of | imported. Tr is calculated on | c) Technical/Other Tariff their imports. the bosis of a unit of measure, | d) Toriff Rate Quotas + World market price of | such at weight, volume, etc., | e) Most-Favored Nation Toriffs the goods unalfected: of the imported good. A ¥. while raise their prices| + Tts protective vale varies | g) in the domestic market. inversely with the price of the | h) + Reise reverse for the| import i) government, and (i) Ad Valorem Tariff: 1) Escolated Tariff + protect the domestic| + A constant percentage of the | k) Prohibitive Tariff import-competing monetary volue of one unit of ||) Import Subsidies industries the imported good. mm) Toriffs as Response: Protective value of tariff on|+ The following sections relate to home producer. such tariff responses te + Gives incentives to deliberately | distortions related to foreign undervalue the good's price on| dumping and export subsidies: ss and bills of lading to 1) Anti-Dumping Duties reduce the tax burden 2) Countervailing Duties > Effects of Tariff on the World Economics + Obstacles to Trade + Domestic consumers suffer a lass in consumer surplus + Encourage Domestic Consumption +) Thereases consumer surplus + High Profits and Increase in Employment + Tariffs discourage efficient production in the rest of the world +) Therease Government Revenues Contact No, 9211122778 Page 4.2.1Chapter-4, U The Instruments of Trade Policy By: CA Nitin Guru 9 Sara aces + Potentially have an economic effect on international trade in goods, changing quantities traded, or prices or both, ‘+ Alter the conditions of international trade. ‘+ NTMs ore not the same as non-tariff barriers (NTBs) as they encompass a broader set of measures. + Two categories of NTMs: (@ Technical Measures: (Gi) Non-Technical Measures: * Product-specific properties such as| + Relate to trade requirements; for example: shipping characteristics of the product, / requirements, custom formalities, trade rules, taxation technical specifications and production | policies, etc. processes, ‘+ These ore further distinguished os: ‘+ Intended for ensuring product quality, | a) Hard measures (e.g. Price and quantity control food safety, environmental protection, measures), rational security and protection of | ) Threat measures (e.g. Anti-dumping and safeguards) and conimal and plant health. ©) Other measures such as trade-related finance and investment measures > Furthermore, the categorization also distinguishes between: 1) Import-related measures 2) Export-related measures 3) Procedural Obstacles > Technical Measures ‘Sanitary and Phytosanitary (SPS) Measures > Technical Barriers to Trade (TBT) ‘> Protect human, animal er plant life from risks | + Goth food and non-food traded products refer rising from additives, pests, contaminants, | to mandatory “Standards and Technical toxins or disease-causing organisms and to| Regulations’. protect biodive + Ban or prohibition of import of certain goods, all measures governing quality and hygienic requirements, production processes, and associated compliance assessments. + For example: prohibition of import of poultry from countries affected by avian flu etc. Tt defines the specific characteristics that a product should have, such as its size, shape, design, labeling / marking / packaging, functionality or performance and production methods, excluding measures covered by the ‘SPS Agreement. Compulsory quality, quantity and price control of goods before shipment from the exporting country. Some examples of TBT are: food laws, quality standards, industrial standards, organic certification, eco-labeling, marketing and label requirements. > Non-Technical messures + Neutralize the possible adverse effects of imports in the market of the importing country. ‘+ Following are the most commonly practiced measures in respect of imports: Contact No, 9211122778 Page 4.2.2